The Mexican Energy Reform: it is nothing less than a feeding-frenzy for energy companies all over the world. In 2013, the government of Mexico made an historic decision. It chose to end the 75-year monopoly of PEMEX – Mexico’s state-owned oil company.
The decision was driven by necessity. Mexico’s lucrative energy sector was/is undercapitalized. This is a by-product of the PEMEX monopoly. The “plus” side for Mexico’s government in locking out foreign companies from the nation’s energy sector was supposed to be that it would reserve the industry’s profits for the Mexican people. In actual fact trying to manage and harvest all these energy riches stretched the resources of Pemex too thinly and it has actually become a money-loser.
Mexico is the Western hemisphere’s 3rd largest oil producer. That’s impressive. However, it has the 4th largest oil reserves in the hemisphere. This differential illustrates that Mexico’s current rate of oil production is not sustainable. Its energy industry requires billions of dollars of investment in new exploration and infrastructure in order to maintain (and perhaps increase) its level of production.
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The opportunity was there. The question was whether Mexico’s government would (could) open up its energy sector in a fair manner which created a level playing field for foreign companies seeking to partner with Mexico in developing its energy industry. The answer to this question is an emphatic “yes”.
Licenses for blocks of land are being awarded via an auction process which is both fair and transparent. This means that even junior energy companies can compete with the giants of Big Oil in grabbing a piece of the action in Mexico’s oil industry. International Frontier Resources Corp (TSX: V.IFR, OTCQB: IFRTF, Forum) was one of the energy companies standing at the front of the line when the first rounds of bidding took place.
To be sure, it took a while for the auction process to commence. It was not a simple matter of merely throwing a lot of blocks of land up for auction. An entire, new government agency (CNH) was needed in order to handle this deregulation in a fair-and-systematic manner.
The process caught many domestic Mexican companies by surprise, as they assumed they would have the inside track on being awarded licenses. But that’s not how it worked.
In this competitive process, some of the onshore blocks had up to 25 bidders, generally from among the world’s junior and mid-tier companies as this initial round of onshore bidding was comprised of relatively smaller blocks. “Home field” proved to be of no advantage to Mexican companies in the bidding.
The major players of the petroleum industry were more interested in the larger offshore blocks. Here the auction process was perhaps even more surprising. When the bidding results were released, Big Oil companies were shocked to see that many of their bids ranked near the bottom of the Mexican government’s rankings.
In fact, the intensity of bidding surprised many of the participating oil companies. The blocks of land were awarded at virtually zero cost (a small bid-guarantee had to be provided). The bidding was with respect to the level of royalties which the bidder offered to Mexico’s government for access to its oil (and gas).
This feeding frenzy for Mexican licenses caused bids to soar.Bids offering in excess of a 70% royalty-cut for Mexico’s government were received on several of the more-lucrative land packages. IFR, itself, was not selected as the winner on any of the blocks for which it bid – initially.
The Company finished between 2nd and 5th in each of the licenses for which it tendered bids. Despite International Frontier’s eagerness to capitalize on this once-in-a-lifetime opportunity, management refused to over-bid on the blocks in which it was interested. IFR’s disciplined approach was ultimately rewarded.
One of the Company’s bids was on the Tecolutla license. Tecolulta is located in the Tampico-Misantla Basin. A recent article by IHS market which appeared in the New York Times has described this onshore oil deposit as “a Super Basin”, with the headline of the article pointing to the “large, untapped potential” of Tampico-Misantla.
“In searching for super basins, we looked for at least 5 billion barrels of oil equivalent (BOE) in conventional remaining reserves in basinsthat had already produced at least 5 billion BOE,” said Robert Fryklund, chief upstream strategist at IHS Markit and a lead author of the report. “We did a global assessment of basins where our study criteria existed—looking for basins with multiple plays and at least two mature source rocks—basically basins that keep on giving and giving. Existing production indicates that there is extensive existing infrastructure.” [emphasis mine]
This was what attracted IFR to bid on the block. The Company was looking for a mature oilfield to develop. Not “mature” in the sense of the oil reserves being nearly exhausted, but mature in the sense that there had been past production, along with existing infrastructure nearby to support new development. This translates into lower cap-ex costs.
International Frontier finished second on the bidding for Tecolutla, Block 24 in the auction process. The highest bid came from a Mexican company, which bid a whopping 68% incremental royalty on the block. But that company was not able to meet the terms and conditions, and no contract was signed.
Tecolutla was awarded to IFR, with its second-place bid of a 31% incremental royalty on this highly prospective license. With overall royalties in the bidding round averaging 49%, the Company ended up toward the lower end of the spectrum with its royalty rate. International Frontier was one of only two Canadian oil companies to have obtained one of the Mexican licenses.
Management was ecstatic. IFR had obtained a choice block of land in a Super Basin, with a bid which (in hindsight) now appears very shrewd. But this was only the starting point in the Company’s plans.
As a junior energy company that planned on swimming with the big fish, International Frontier was interested in bringing in a larger partner, specifically a Mexican partner. What IFR was looking for was a partner who could supply experience and expertise to compliment what it brought to the table itself.
Grupo Idesa is the corporate partner with whom International Frontier entered into a joint venture – a 50/50 partnership. The two companies formed Tonalli Energia as the corporate vehicle for the joint venture, and it was actually Tonalli that was selected as the winning bidder on Tecolutla.
IFR brings its Canadian oil expertise to the table. Idesa supplies its experience in dealing with Mexico’s regulatory framework, as well as engineering and logistics expertise. A major player in Mexico’s petrochemical industry, Idesa has previously engaged in large, successful joint ventures with other leading companies in the petrochemical industry.
Further solidifying the project’s potential, International Frontier brought in an additional partner to the joint venture – the Canadian government. IFR’s activities attracted the interest of Export Development Canada (EDC). EDC is a vehicle created by the Canadian government to support Canadian industry abroad.
In this particular instance, EDC is providing International Frontier with financial support. As an EDC partner, the Company is entitled to the Government of Canada’s “AAA” credit rating with respect to some of its financial activities. Not only does this translate into cheaper costs for capital, it provides some instant credibility for Tonalli Energia and IFR itself.
International Frontier now had the business end of the Tecolutla project wrapped up. The Company has a prime license to develop. It has an ideal Mexican corporate partner to help accelerate development. It has the active support of the Canadian government. With the successful completion of a recent $5.1 million financing, IFR is fully funded for its 2017 operations.
This leaves International Frontier with one operational priority: execution. Based in Alberta, the Company has many years of operational experience, both within the Alberta oilpatch as well as other operations inside and outside Canada. Management views Block 24, and Mexico in general, as being at a similar level of development as Alberta in the 1970’s.
IFR has a deep team at both the management and board level. The Company is led by Steve Hanson. Hanson’s expertise is in finance, corporate development, and venture capital. With more than 25 years of experience, Hanson previously served in management and on a number of private and public company boards.
At the operational level, IFR relies upon COO Andy Fisher. Fisher has more than a quarter century of experience in the oil & gas industry, running through the full spectrum of operations.
Ignacio Quesada was brought in as a Director specifically to help the Company advance its Mexico growth strategy. In addition to his 20 years of expertise in strategic planning and financial solutions, Quesada previously served as the CFO of Pemex. While there, he played an important role in the development of new business initiatives, including Pemex’s joint ventures with outside companies.
The latter point is of interest because even though the Pemex monopoly has ended, this state-run corporation is very much still in the picture as part of the Mexican Energy Reform. Altogether, more than 300 onshore blocks of land have already been earmarked for new licenses in the auction process. However, out of that total are 150 Pemex blocks which are to be farmed-out from the state monopoly.
To date, only a few dozen licenses were awarded during the first round of auctions. The second round of auctions is about to begin, with IFR already focusing on Round 2.3. Bidding will take place on a total of 14 additional blocks. Two factors are of great interest to the Company.
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First, eight of the 14 blocks in Round 2.3 are located in Veracruz state, the same state in which the Tecolutla block is located. Of equal importance is that these next licenses up for grabs will be for much larger blocks. Indeed, some of the blocks available in this round are as much as 10 – 20 times larger than the Tecolutla block.
Obtaining just one of these larger blocks would represent multiples of the blue sky potential of Tecolutla alone. And management is already extremely enthusiastic about the potential of Block 24.
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International Frontier plans to hit the ground running with its development of Tecolutla. Historic production from the oilfield ranged from 256 – 453 bbls/d of light crude. This is based upon seven wells drilled between 1956 and 1972. The Company will not be satisfied with merely equaling those production numbers, for three reasons.
First, IFR has access to 3D seismic (already completed), which didn’t exist when those earlier wells were drilled. Second, IFR will be employing 21st century oil extraction engineering and technology. Third, and perhaps most importantly, management strongly believes that previous drilling missed the best part of the Tecolutla field.
Initial drilling will focus on two wells (as indicated above). Well Tec 10 is to be drilled in the first half of 2017, as soon as final permitting has been secured. Tec 11 is to be drilled in the second half of 2017, with the horizontal shaft designed to significantly improve recovery rates.
As always, an element of good fortune is required in energy investing. There is no guarantee that the Tecolutla wells will fully meet the Company’s expectations. There is no guarantee that IFR will be a successful bidder in Round 2.3. But that’s how investing works.
Buy on rumor; sell on news. Investors who choose to wait until after IFR has demonstrated more success in its Mexico operations will not be able to buy into this $35-million market cap at anything close to the current share price of $0.32.
https://www.internationalfrontier.com/s/Home.asp
FULL DISCLOSURE: International Frontier Resources Corp is a paid client of Stockhouse Publishing.